(PUB) Investing 2016

passed, the larger and faster the account grows. That is the power of compound- ing—by constantly adding to your investment, you increase the potential return, going from what seems like a paltry $1,000 initial investment at age 15 to $225,000 by age 60, simply by adding $1,000 a year to the account, achieving a 6% annual return and pay- ing no taxes on your income and gains. With larger initial (and subsequent) investments, you get even more bang for your buck. But I also put together another sce- nario that may be more realistic, par- ticularly when we’re talking about real markets and real teenagers. First off, few teenagers are going to be able to earn $5,500 in a summer, though they might be able to hit that number or high- er if they work during the school year. Also, as you know, markets don’t compound in a straight line. They go up and down. So, in the charts at the bottom of page 12, I’ve assumed that our teen (or guardian angel) is not only socking away more modest sums, but does so from the age of 12 to the age of 25, when, presumably, Junior will be out working, saving and investing on his or her own. In the three scenarios, I’ve assumed the actual returns from Total Stock Market , Total Bond Market and Wellington from 2002 through 2015. Despite two stock bear markets during this period, Wellington, which keeps about 60% of assets in stocks and the remainder in bonds, beat the returns from Total Bond Market and came close to matching those from Total Stock Market. These charts might be just the thing to show the teen or young adult you’re interested in leading down the road to retirement. I hope I’ve both made the benefits of funding an IRA clear, and simplified it enough that a young inves- tor can understand it. But the question remains: How can we get a teenager to save for retirement? You probably can’t. So, my advice is to help them. That’s what I did with both of my kids. Let’s assume you can afford to match their summer earnings. Do it.

the initial $100 investment) generated because you gained 20% not only on your original investment, but also 20% on all the money you earned in the first year. While this may not seem like an impressive amount, with each pass- ing year that earnings potential grows even higher, so long as the investment prospers. If you start actively investing a set amount each year, adding to the amount generated by what the invest- ment earns on its own, you create even larger potential earnings. In the table on page 12, I set up several different savings scenarios for illustration. All of them assume a 6% annual return, with the difference in scenarios being the amount contrib- uted per year, increasing in increments from $1,000 to $5,500 (the maximum currently allowed under IRS rules for investors age 49 and younger for 2015 and 2016) from the age of 15 to 70. Finally, the sixth scenario attempts to show a conservative, natural progres- sion a young person might follow as they age and gain employment: Starting with their first summer job at age 15, they invest $1,000 a year until they graduate from college and get settled into a career, bumping their contribu- tion up to $2,000 a year at 23. By age 30, they will (hopefully) be well-estab- lished and able to again bump their contribution up to $4,000, and by 40, to $5,500, an amount they continue to contribute up until retirement. You can see that the greater the con- tribution and the greater the time that’s

no requirement on distributions—if you don’t feel like taking money out or don’t need it, you can leave it in there to continue growing. Why do I continue to preach the benefits of IRAs as great starter invest- ments for teenagers or young adults? Simple: Taxes and the power of com- pounding. If your child is only working for the summer, or just starting their professional career, they will likely be in one of the lowest tax brackets, mak- ing it a fantastic deal to pay taxes on their retirement savings now as opposed to when they are older and in a higher bracket. And, in this economy, many first-time jobs don’t come with 401(k) retirement plans attached, so there’s no other available vehicle for forced retire- ment saving. Plus, for most, an IRA gives you more flexibility over where and how to invest. 401(k)s often have few, and sub-par, investment choices. The power of compounding is what really makes any kind of tax-deferred investment smart. The definition of compounding is “the act of generat- ing earnings from previous earnings.” While I know you know what that means, here’s how I’d think about explaining it to a younger investor: Let’s say you make a $100 investment in a fund that rises 20% in a year. After that year, you’d have $120. Instead of selling your shares, you let them ride, and the fund gains another 20% the next year, bringing your investment value up to $144. That’s an additional $4 in gains over the first year (or 4% on >

LOW COSTS Saving a Tree?

VANGUARD IS NOTORIOUS for cutting expenses to keep the fees on its funds and ETFs rock-bottom. Well, I’ve got a suggestion: Try cutting back on envelopes. No, I’m not talking about the self-mailers that Vanguard used to include with account and transaction statements. I’m talking about the envelopes surrounding the envelopes. I recently emailed Vanguard asking for some self-

mailers because, well, they hadn’t sent me any in a while. I think a picture speaks a thousand words, so all I’ll say is, when 21 envelopes are packed in seven envelopes and then packed in one envelope, well, maybe Vanguard still has room to trim the fat.

14 • Fund Family Shareholder Association

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